Charlie Bean (Deputy Governor BOE): in response to a question about the famous Milton Friedman quote “Inflation is always and everywhere a monetary phenomenon”: “Inflation is not always and everywhere a monetary base phenomenon”:

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Donald Kohn “I know of no model that shows a transmission from bank reserves to inflation”

DEAD WRONG. I discovered the model in JULY 1979. It still works as magnificently today as it did then. Long-term (CORE), inflation bottomed in JAN (as previously predicted in JUNE 2010 – when I first looked at it).

Doesn’t anyone in government suspect that there might an actual cost in being seen by the entire world as incompetent as professional wrestling referees?

Sometimes during matches, referees will be knocked down by wrestlers. This is usually to allow for a wrestler to use a foreign object or perform an illegal move, or for another wrestler to run in and be able to get away with it.

As a general rule, professional wrestling referees will not make a decision based on anything they do not personally witness happening in a match. This is used to explain the ubiquitous “distract the referee” tactic, used by heel managers to take the referee’s attention away from the in-ring action, allowing the heel wrestler to cheat with impunity while the official’s back is turned, or vice versa…

An effective gimmick for heels is to have a personal referee, who is on the permanent payroll of the heel… This is a broader extension of the “corrupt referee” gimmick, in that the referee’s allegiance is openly made public, and is blatantly flaunted to incense the audience — the referee himself is exempt from punishment due to his official position.http://en.wikipedia.org/wiki/Referee_%28professional_wrestling%29

Resolving the structural budget imbalance is indeed important, as we have argued many times in the past. If left unchecked, chronic primary deficits will lead to an increasing stock of federal debt as a share of GDP, raising long-term interest rates and thereby crowding out private investment. This would reduce growth over the longer term and increase the risk of a fiscal crisis.

Bernanke used the analogy of a family with credit-card debt to explain how the debt ceiling differs from congressional spending decisions.

A refusal to lift the ceiling would prevent the Treasury from making payments on debts already accrued by Congress. That’s like a family trying to solve its finance problems by refusing to make debt payments, Bernanke said.

May or may not be the best analogies, but the Treasury and the Fed seem to have troubles communicating the extreme seriousness of the debt ceiling limit.

It may happen that the Congress raising the limit, in which case this matter will be forgotten.

There was a blog post here and in the comments section commentators did not seem to appreciate Geithner’s warnings. So imagine communicating this to politicians!

The Treasury has financial assets and it can sell them to roll the Treasuries. It can do lots of other gymnastics.

Some suggest that the government can sell land to take care of this issue.

However such actions may not be the most comfortable as the sale price may be far below market price.

(Of course, they may use the “coin”… possible they don’t know this law and may not want to exercise this option because there is a possibility that the law is changed if the coin escape hatch is used).

Ramanan, I’m genuinely curious, if Tsy wanted to short the futures market quietly (of course they could move money through Pentagon, CIA and DEA secret accounts), just how heavy a bet could Uncle Sam make against Uncle Sam? And once it did, announce that the US was defaulting on its debt… take profits… then announce that everything was back on track for payment.

Ha ha, that would never happen of course, Treasury Secretaries come out of either Wall Street or the oil path. A Texan might try that, just out of spite mostly, but Geithner and his crew act are just in DC for their “semester in Washington” and wouldn’t dare.

What’s at stake is issuance new debt, Congress has no legal authority to refuse to pay debt service on existing debt, its not at their “pleasure or convenience” to say no, and no law it passes (the debt ceiling or the $300 million cap on US Notes) can block enforcement of the Constitution. This isn’t a difficult point to understand. Naturally,at the link Bernanke makes plain that he doesn’t (“‘even the possibility of default on existing debts’ could have negative consequences”).

By virtue of the power to borrow money “on the credit of the United States,” Congress is authorized to pledge that credit as assurance of payment as stipulated — as the highest assurance the Government can give — its plighted faith. To say that Congress may withdraw or ignore that pledge is to assume that the Constitution contemplates a vain promise, a pledge having no other sanction than the pleasure and convenience of the pledgor.
Perry v. United States 294 US 330 (1935)http://supreme.justia.com/us/294/330/

“By virtue of the power to borrow money “on the credit of the United States,” Congress is authorized to pledge that credit as assurance of payment as stipulated — as the highest assurance the Government can give — its plighted faith. To say that Congress may withdraw or ignore that pledge is to assume that the Constitution contemplates a vain promise, a pledge having no other sanction than the pleasure and convenience of the pledgor.”

Ha ha ha … :-)

I understand that the debt ceiling thing is contradictory to Constitution, but the important thing is that since people live with contradictions … when the ceiling is close … the Treasury may start to worry unnecessarily with people working there unsure of what to do and the first thing they will do is start selling assets.

Ed Rombach Reply:March 4th, 2011 at 10:38 am

Fed disclosures made about a year ago revealed that the $29 billion Bear Stearns Maiden Lane I legacy portfolio had been hedged by BlackRock with many thousounds of short positions in 5yr and 10yr Tsy futures in addition to puts on those futures.

beowulf Reply:March 4th, 2011 at 12:16 pm

Its not the debt ceiling per se that’s the obstacle to paying on the debt, its section b of 31 USC 5115 (“United States currency notes”).(a) The Secretary of the Treasury may issue United States currency notes. The notes—
(1) are payable to bearer; and
(2) shall be in a form and in denominations of at least one dollar that the Secretary prescribes.
(b) The amount of United States currency notes outstanding and in circulation—
(1) may not be more than $300,000,000; and
(2) may not be held or used for a reserve.

US Notes are interesting, while they’re public debt, they’re not counted against the statutory debt limit. If Tsy was up against the debt ceiling, they could put Congress and the Fed on the horns of a dilemma by printing US Notes (“in a form… Secretary prescribes” could be electronically) to fund government operation.

If the Fed objects (that is refuses to accept Secretary’s deposit of US Notes), take them to US district court for a declaratory judgment to throw out either Perry v. United States (which would allow US to default) or 5115(b) (to allow US Notes without constraint) as bad law. Since district court judges CAN’T throw out Supreme Court precedent, that one’s a layup.

Tsy could also argue that since Federal Reserve System exercise federal executive power, it either reports to president or is unconstitutional, but that argument isn’t necessary for a victory in this matter, so maybe save that one for a rainy day. When that case does come up (and it will someday), I just hope DOJ has the presence of mind to caption it, United States of America v. United States of America.

beowulf Reply:March 5th, 2011 at 6:56 pm

Ramanan,
There’s also that Tsy can issue gold proof coins of any denomination with 30 days notice in Federal Register (debatable whether that’s needed for new versus “changed” coin specs). So instead of selling them with the process we discussed for platinum coins, gold coins can be kept at Treasury Building (in a walk-in Mosler safe perhaps) with gold certificates issued against their jumbo face value. Gold certificates, of course, are still legal tender. Easy peasy though I imagine gold bugs would not be amused. :o)

Ramanan, I do try to anticipate your every objection… Remembering that the legal tender value of minted coins is their face value, see Nortz case, footnote 1: :o)The form of the gold certificates here in question is stated to be as follows:

“This certifies that there have been deposited in the Treasury of”

“THE UNITED STATES OF AMERICA”

“ONE THOUSAND DOLLARS”

“in gold coin payable to the bearer on demand.”

“This certificate is a legal tender in the amount thereof in payment of all debts and dues public and private.”

For everyone, and to clarify a point made by Matt Franko, below is a list of Primary Dealers obtained from a link to the New York Fed (http://www.newyorkfed.org/markets/pridealers_current.html). These are the only institutions that are authorized to deal directly with the Fed. They are the ones the Fed is putting bids for Treasurys to, and of course as Warren points out since the Fed is bidding no one is forced to sell. In open market operations the Fed will ASK the dealers to OFFER securities. Look at who they are and make up your own mind about why they might want to sell to the Fed, and then think about these firms’ balance sheets and what they might look like afterwards. Then think of their customers and their parent companies (lots of banks) and how it might go from there. I don’t see an obvious transmission to anyone other than large financial institutions and their largely institutional customer base who must be making portfolio decisions, as Warren says.

List of the Primary Government Securities Dealers Reporting to the Government Securities Dealers Statistics Unit of the Federal Reserve Bank of New York

73% of what the Fed took from PDs today was just auctioned by Treasury a week or two ago so at least for today, net it doesnt look like they are changing out much current holders of Treasuries into other maturities.
Resp,

I see how it’s almost no bonds but where is the support on excess reserves coming from?

Tom Hickey Reply:March 6th, 2011 at 10:24 pm

Fed is paying a support rate on excess reserves presently. It is called Interest On Excess Preserves (IOER). It is higher than the Federal Funds Rate (FFR) which is the overnight interbank rate in the US.

Someone is even claiming that the reason the money multiplier is not working is that the Fed is bribing banks with the IOER for some mysterious reason. :)

… the money multiplier is broken but we know who broke it and we know how to fix it. Just lower the IOER, even make it a penalty rate, and the excess reserves will turn into money quite quickly. (source)

oh okay well that makes sense. So we really already have an entire system set up to subsidize banks for government spending without the use of bonds…we just aren’t doing it b/c we like bonds for some reason. okay sounds like a beauracratic m.o. to me.

What is the value of the IOER then? Is it really just another way to subsidize banks rather than through bond interest? This would be easier b/c the Fed wouldn’t need to “offload” all those bonds every time the Treasury spent money. All they’d need to do was manipulate the IOER.

I just read that Milton Friedman said in 1999 that the Fed could be run by a computer and probably more effectively. haha!! He may be right on that one eh?

beowulf Reply:March 7th, 2011 at 12:20 am

Randy Wray had some interesting things to say about this last May:

Bernanke had long argued that what Japan needed was “quantitative easing” to supplement the zero rate policy. He was always vague about what that means, but he had this idea that the Fed can “push on a string“-encourage banks to lend and borrowers to borrow by “pumping liquidity” into the economy. This would take the form of increasing bank excess reserves-providing them with far more reserves than they wanted to hold-on the belief they would then lend.

Bernanke apparently believes in the discredited notion of a “money multiplier”: when banks have excess reserves they expand loans and deposits by a multiple. But banks never have operated that way… So what quantitative easing really amounts to is keeping excess reserves in the system and the overnight rate near zero. Nothing new about it–”quantitative easing” is a nice slogan with no economic implication. Banks will not lend and borrowers will not borrow because they know we are in a deep and long recession…

So while I think most people overestimate the Fed’s power, I do agree that we ought to tie the hands of the Wizard. I propose that Congress mandate the Fed set the overnight rate at 25 basis points (0.25%) and leave it there. Forever. That would be the extent of monetary policy in the US. A very simple robot would replace the FOMC, programmed to pay 25 basis points on reserves, and charge 50 basis points on loans of reserves to chartered banks.http://www.newdeal20.org/2010/05/06/interview-with-randall-wray-truths-and-myths-of-the-federal-reserve-10452/

Federal Reserve Bank of Kansas City President Thomas Hoenig said the central bank is “monetizing debt” with its purchases of U.S. Treasuries, a program that he says may spur inflation.

“Yes, we are monetizing debt,” Hoenig said today in a speech in New York. “You buy bonds and you monetize debt. Right now, a lot of that is going into excess reserves so it is not having an immediate effect on inflation. It will initiate inflationary impulses. It takes time.”

Don Kohn (Former FRB Vice Chair):”I know of no model that shows a transmission from bank reserves to inflation”.

I consider this quote a surprising deception about the effects of QE. Kohn must certainly know that the Fed’s purchase of securities from non-banks increase the total of bank deposits as well as bank reserves. While the reserves have no inflationary impact, the increased bank deposits certainly have that potential.

The reason we have had no dramatic increase in prices due to the added spending power from QE is very likely due to the fact that most of the sellers of securities were large financial institutions and the wealthy whose propensity to save under recessionary conditions is very high.

William: While the reserves have no inflationary impact, the increased bank deposits certainly have that potential.

If and when consumed. Much to the Fed’s chagrin that is not happening and the Fed cannot force buyers to buy by putting cash in their pockets.

Wm. The reason we have had no dramatic increase in prices due to the added spending power from QE is very likely due to the fact that most of the sellers of securities were large financial institutions and the wealthy whose propensity to save under recessionary conditions is very high.

The Fed did not force anyone to sell their tsys. People sold them because they figured they were getting a good deal and they had another use for their money (indifference level). The other use happened to be another form of saving instead of consuming, which was predictable given the holders, as you point out. The Fed is either stupid in thinking that this would raise consumption, or else figured that the funds would go into higher risk assets like equities, making equity prices “higher than they would be otherwise” and increasing the wealth effect.

If the goal had been to manage the yield curve, then the Fed should have targeted price rather than quantity.

This question of bank vs non-bank holders of T-Bills has been bugging me as well. It seems most of the discussion here of QE has focused on the bank holdings. I agree that simply swapping reserves for treasuries shouldn’t affect inflation.

Unless we believe that the private sellers of T-Bills are content to hold cash balances with their proceeds, at least some of those proceeds must be going into equities or other assets …. which could cause asset price inflation.

Equity prices have been rising. Are we certain that none of that rise can be attributed to QE (by which I mean that portion of QE that went to non-bank holders)?

Is there a flaw in my reasoning? Does asset price inflation matter, or should we only worry about CPI inflation?

Ken, it can be argued that the Fed knew in advance and planned on some of the liquidity provided by QE flowing into other assets, driving their price “higher than they would be otherwise.” It does seem that the intention was to enhance the wealth effect to spur more consumption to stoke the economy because people felt richer.

However, there is a limit to levitating prices with increased liquidity, or maybe only expectation of price rise due to increased liquidity, there being no clear causal transmission.The result is market price exceeding fundamental value based on fundamentals (what the asset can reasonably produce), and a growing divergence is not upwardly sustainable forever. Such markets are based on the greater fool theory, which is a variant of the game of musical chairs, unless fundamentals start to catch up before the music stops.

CPE inflation is historically very low and the people who are concerned about inflation are barking up the wrong tree. What they are actually concerned about is a potential (they think inevitable) currency crisis, purportedly because the Fed is “printing” so much money, i.e., increasing the monetary base.

If the economic improvement doesn’t result in improvement of fundamentals, eventually artificially driven asset prices will break down, and there will be a run for the door. That is the concern now, for example, if you follow trading blogs like Zero Hedge.

anyone can sell their tbills at any time, whether the fed is buying or not.
the way markets work is that when the fed or anyone buys, they give the price an upward bias until sellers emerge.

so the question is, do the fed purchases lower rates to the point where people decide to sell their securities and instead consume?

highly unlikely, mainly because lower rates are a two edged sword. With the govt a net payer of interest, lower rates lower the interest paid by govt to the private sector. And when the fed buys securities, the interest it earns would have otherwise been earned by the private sector.

so with qe comes a bias towards a lower term structure of rates due to the buying, and also a reduction of interest income earned by the private sector.

also, in general sellers of securities do so with funds that are already considered ‘savings’ (pension funds, IRA’s, corp reserves, etc.) and are merely shifting funds from one financial asset to another, and do not sell securities to increase consumption.

Can equity prices be attributed to qe?
Possibly, via a couple of channels that I can think of.
One is via people who believe qe is inflationary make portfolio shifts from fixed income to equities. (Near term, whether they are right or wrong longer term is of no consequence)
Another is that with a lower term structure of risk free rates, the discount rate for equities is lower, which helps valuations.

Tom Hickey Reply:March 2nd, 2011 at 7:14 pm

Warren: the idea of ‘liquidity provided by qe flowing into other assets’ strikes me as out of paradigm?

That did seem to be the Fed intention, now confirmed by Bernanke, and I know for a fact that many money money managers piled into equities based on expectations that QE2 would automatically lift the market. I said at the time it was crazy, but it did happen that way, as far as I can tell.

yes, it was sort Bernanke’s intension.
though his intention has changed over time…

yes, the price of equities went up, along with earnings and modest top line growth, as has been happening for quite a while.
none of that is a function of qe

Tom Hickey Reply:March 3rd, 2011 at 5:05 pm

none of that is a function of qe

Agreed.

Matt Franko Reply:February 28th, 2011 at 4:32 pm

William,
Under the QE2, the Fed is buying Treasury Securities from Dealers, not the public per se. They are buying at the rate of new issuance, so net they cannot be buying from institutions or people. This is far from a “free market” imo.

Exactly. If your checking account is credited with $100,000, but your investment account is debited $100,000 at the same time, it’s ridiculous to suggest this makes people spend. Mostly what’s happened is interest income has been reduced.

And note that the way the Fed’s actually carried out QE, they aren’t reducing rates anyway, except very marginally perhaps, but highly doubtful it’s had an economically significant effect on the term structure. The empirical evidence on Fed asset purchases has come to the same conclusion..

Warren Mosler: “I’d say QE does lower the term structure of rates, all else equal.”

It’s pretty hard to make that case if you look at the charts. Yields soared after QE-1 commenced and didn’t start falling again until after it was done. And right on cue, yields went sharply higher with the start of QE-2. The problem is the Fed had a mixed message, claiming that QE-2 would bring long term rates lower and at the same time stimulate higher inflation. How could they think that they could explicitly advertise a policy of raising the level of inflation and not scare bond investors? The fact that long term bonds began selling off long before the belly of the curve lends support to the view that the market was spooked about inflation. It all ties in with the sell the dollar / buy commodities trade which is simply two sides of the same coin. If past is prelude to the future, I think I’d want to be a buyer of bonds when QE-2 is over.